Cap­i­tal­ism’s mes­sage of tough love

The Washington Post - - CAPITAL BUSINESS -

Gen­eral Elec­tric and Sears have fallen on hard times, and that tells us a lot about U.S cap­i­tal­ism. Both were once great en­ter­prises — sym­bols of Amer­i­can in­ge­nu­ity and imag­i­na­tion. The temp­ta­tion will be to blame their trou­bles on mis­man­age­ment. The real les­son is starker. It is that no busi­ness, no mat­ter how his­tor­i­cally in­no­va­tive or pow­er­ful, is guar­an­teed im­mor­tal­ity.

Here’s a sum­mary of the com­pa­nies’ trou­bles. Sears en­tered bank­ruptcy in Oc­to­ber. It will ei­ther go out of busi­ness (its stores and mer­chan­dise will be sold, with the pro­ceeds used to re­pay debts) or a much smaller store chain will sur­vive. Al­though GE doesn’t face bank­ruptcy, its prof­its have dropped sharply, and it is con­sid­er­ing sell­ing more of its busi­ness units.

Both firms helped weave the United States’ eco­nomic ta­pes­try. The mailorder cat­a­logues of Sears and its main ri­val, Mont­gomery Ward, cre­ated na­tional mar­kets for con­sumer goods, from clothes to tools. Sears is­sued its first multi-hun­dred-page cat­a­logue in 1894. It was the Ama­zon of its time. By the new cen­tury, it was ful­fill­ing 100,000 or­ders a day, re­ports econ­o­mist Robert J. Gor­don in his book “The Rise and Fall of Amer­i­can Growth.”

GE — Thomas A. Edi­son was one founder — pro­moted elec­tri­fi­ca­tion, which reached 96 per­cent of ur­ban dwellings by 1940. As early as 1917, GE was tout­ing elec­tric ap­pli­ances as “ser­vants, de­pend­able for the mus­cle part of the wash­ing, iron­ing, clean­ing and sew­ing. They could do all your cook­ing — with­out matches, with­out soot, with­out coal.” These glory days are long gone. GE’s stock is trad­ing at about $9 a share, down from its peak of more than $30 in the sum­mer of 2000.

For both com­pa­nies, eco­nomic pres­sures changed the terms of com­pe­ti­tion. Sears ul­ti­mately could not adapt to a world that in­cluded Wal­mart, other “big box” stores and the In­ter­net. GE tried to di­ver­sify from its tra­di­tional in­dus­trial base of ap­pli­ances, light­ing, elec­tric gen­er­a­tors and jet en­gines.

There is a life cy­cle that ap­plies to al­most all firms, es­pe­cially large, suc­cess­ful firms. If they have in­tro­duced some im­por­tant or pop­u­lar prod­uct, these firms can grow rapidly for some pe­riod, of­ten decades. But sooner or later, their mar­ket will be­come ma­ture. Growth and profitabil­ity may weaken. Com­pe­ti­tion may strengthen.

This leaves firms in a pre­car­i­ous po­si­tion. The prac­ti­cal ques­tion is: What do they do with their present prof­its, which flow from their past suc­cess? The choices are mostly unattrac­tive.

First, cor­po­rate ex­ec­u­tives may hoard present prof­its and de­fend their ex­ist­ing mar­kets as best they can. This might suc­ceed for a while, but all the spare cash hides firms’ un­der­ly­ing weak­nesses and en­cour­ages waste­ful spend­ing, in­clud­ing ex­ces­sive cor­po­rate com­pen­sa­tion.

Sec­ond, firms can pay high prof­its to share­hold­ers through div­i­dends or share re­pur­chases. (In the­ory, when com­pa­nies buy their own stock, their share prices should in­crease.) This min­i­mizes the dan­gers of waste­ful spend­ing but doesn’t pro­vide a path for fu­ture growth.

Third, com­pa­nies can find some new growth busi­nesses to off­set their ma­ture busi­nesses, ei­ther by in­vest­ing prof­its in re­search and de­vel­op­ment or by merg­ing with some other com­pany. This seems the most re­spon­si­ble path, but it is lit­tered with prac­ti­cal ob­sta­cles. Count­less bil­lions have been wasted on merg­ers that didn’t suc­ceed and R&D spend­ing that led to dead ends.

Against this back­drop, the dis­tress at GE and Sears is hardly unique. Sears couldn’t com­pete against more mod­ern re­tail­ers. GE’s car­di­nal mis­take was main­tain­ing its con­glom­er­ate struc­ture: many busi­nesses un­der one cor­po­rate roof. The the­ory was that good man­agers — and GE con­sid­ered it­self a ci­tadel of good man­agers — could master any busi­ness.

For nearly two decades, chief ex­ec­u­tive Jeff Im­melt (2001-2017) sold busi­nesses — in­clud­ing ap­pli­ances and NBC Uni­ver­sal — and bought oth­ers to shift the firm’s prod­uct mix. And yet, his suc­ces­sor said:

“I con­cluded that we were run­ning too many busi­nesses at once to do them all jus­tice. We had to ad­mit we didn’t have the [needed] fi­nan­cial and man­age­ment band­width.”

What this sug­gests is that, even in good times, Amer­i­can cap­i­tal­ism ex­acts a con­sid­er­able hu­man toll. To sur­vive, Sears has al­ready shut­tered 1,700 stores in­volv­ing more than 200,000 jobs, re­ports the Wall Street Jour­nal. (The to­tal in­cludes Kmart stores, also owned by Sears.) There is an ebb and flow to busi­ness, based on shift­ing tech­nolo­gies, con­sumer tastes and com­pe­ti­tion. Suc­cess in one busi­ness doesn’t guar­an­tee suc­cess in an­other.

Last year, GE was re­moved from the Dow Jones In­dus­trial Av­er­age. It was the last of the orig­i­nal 12 firms to go. The oth­ers in­cluded en­ter­prises mak­ing shoes, re­fin­ing sugar and pro­duc­ing lead — all ma­ture in­dus­tries. Would we be bet­ter off if they were still our lead­ing firms? Hardly.

Cap­i­tal­ism of­fers tough love. Its prices are also its virtues. We pay a high price for eco­nomic flex­i­bil­ity but ben­e­fit enor­mously from the ris­ing liv­ing stan­dards it pro­duces.

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